Focus on Economic Data: Productivity - October 2001

Announcement

The Bureau of Labor Statistics of the U.S. Department of Labor today reported preliminary productivity data--as measured by output per hour of all persons--for the third quarter of 2001. The preliminary seasonally-adjusted annual rates of productivity growth in the third quarter were:

2.2 percent in the business sector and
2.7 percent in the non-farm business sector.

In both the business and the non-farm business sectors, productivity increases in the third quarter occurred because hours fell more than output. In manufacturing, productivity changes in the third quarter were:

The original press release is available at: www.bls.gov/news.release/empsit.nr0.htm

Of these five numbers, the one most often discussed in press and television reports is the rate of increase in productivity in the non-farm business sector.

Data Trends

The increase in productivity growth during the third quarter of 2001 was the highest in a year. While the Department of Labor made adjustments in the figures in an attempt to accurately reflect the effects of the terrorist attacks of September 11, it is likely that even these adjusted figures will be subject to future revisions that are larger than normal.

The latest productivity data indicate that businesses are adapting to the slowing growth in total output that has occurred over the past few quarters by adjusting employment and the hours worked. Employment has decreased over the past three months and businesses are reducing the hours worked by each employee as well. In the third quarter, output in the non-farm business sector decreased (-1.0 %) and hours of employees decreased at a faster pace (-3.6%). The decrease in output by itself lowers productivity. The fact that 3.6% fewer hours were used to produce increases the measured productivity. Thus, the change in productivity was -1.0% + 3.6% = 2.6%. (The numbers do not exactly add up to the reported number, 2.7, due to errors in rounding). See the latest Unemployment case for a description of recent changes in employment.

In spite of the increase in the most recent quarter, the changes in productivity during 2001 have been less than the changes in the previous three years. The increases in productivity for all of 2000 (annual average of 3 percent) exceeded increases in 1998 (2.6 percent) and 1999 (2.3 percent). The longer run trend in productivity has allowed real GDP per capita to increase. It also means that wages for workers can increase and can do so without excessive upward pressures on prices. Hourly compensation rose at an annual rate of 4.8 percent during the quarter. Unit labor costs are the costs of labor per unit of output. Thus the increase in unit labor costs is the percentage increase in hourly compensation minus the percentage increase in productivity. Or 4.5% minus (2.7%) = 1.8%.

The increase in unit labor costs provides evidence that there are still some minor inflationary pressures. However the recent slowing growth and the decline in the most recent quarter in real GDP and increase in the unemployment rate to 5.4% provide additional evidence that inflationary pressures are unlikely to be serious.

Productivity Growth in the Future

On November 6, 2001, the Federal Reserve Board lowered the target federal funds rate to its lowest level in 40 years. In their announcement, they made the following statement concerning productivity.

Although the necessary reallocation of resources to enhance security may restrain advances in productivity for a time, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate.''

The Federal Reserve recognizes that the terrorist activities on September 11, 2001 prompted increased security measures for businesses across the country. That increased spending on security means that it will take more hours of labor to produce the same output. Thus the expectation is that productivity will fall as a result of that change. However, the Federal Reserve remains optimistic that productivity growth will continue in the long run after the economy has adjusted to the needed increased security expenses.

Historical Data Trends

From 1950 to 1973, productivity grew at an average annual rate of 2.8 percent. But from 1973 to 1995, growth in productivity slowed to an increase at an annual rate of 1.4 percent. From 1996 to 2000, productivity again increased at an annual rate of 2.5 percent.

The slowdown, beginning in the 1970s, and the increases in the late 1990s are not fully understood. The analysis of the Council of Economic Advisers is that about .47 percent of the recent increase can be explained by the effects of more computers and software being used in many businesses. Dramatic changes in the production of computers themselves helps explain about another .23 percent. The quality of labor (increased education and more experienced workers) explains about .05 percent.

The rest is not understood. It may be due to cyclical pressures (that is, fewer workers were being added to employment rolls, but those who were working were producing more) and perhaps to the effects of lower business costs as a result of business use of the internet.

For the future, education and experience will not likely continue to make significant advances. The computer contribution to increases in productivity will probably drop. A consensus forecast is for a declining growth rate in productivity and therefore in real GDP growth rates.

1950 -73

1973 - 95

1995 - 00

Future

Growth in hours worked

1.6%

1.7%

1.7%

1.2%

Productivity

2.8%

1.4%

2.5%

2.0%

Real GDP

4.2%

3.0%

4.0%

3.0%

(The percentage change in hours worked plus the percentage change in productivity is not always exactly equal to the percentage change in real GDP due to rounding and the inclusion of slightly different measures in the productivity and hours calculations. However, increases in the growth in hours worked and increases in productivity will cause similar increases in the growth rates of real GDP.)

Definitions of Productivity

It is a challenge to understand all of the different productivity measures. Changes in productivity are calculated for the business sector, the non-farm business sector, manufacturing (including calculations for durable goods and non-durable goods manufacturing), and even non-financial corporations.

The broadest measure is productivity in the business sector, which comprises 77 percent of GDP. The business sector excludes government and nonprofit organizations, employees in private households, and the rental value of owner-occupied housing. The non-farm business sector excludes all of those activities plus farming and accounts for about 76 percent of GDP. Productivity in the non-farm business sector is the most commonly used measure in studies of productivity. The reason agriculture is removed is because output and therefore productivity are significantly influenced by weather changes.

Non-financial corporate output measures productivity for the non-farm business sector excluding such activities as banks, securities brokers, insurance carriers, and unincorporated businesses. It accounts for 53 percent of the value of GDP. Manufacturing includes about 17 percent of business employment. The manufacturing of durable goods includes machinery, computer equipment, electronics, appliances, automobiles and trucks, lumber, furniture, and stone, glass, and cement products (11 percent of employment). Manufacturing of non-durable goods (6 percent of employment) includes food, apparel, paper products, publishing, chemicals, and petroleum products. The manufacturing data are actually calculated from different sources than the overall statistics and can differ slightly from the other data.

How The Data Are Calculated

Productivity data represent the amount of goods and services (in real terms) produced per hour of labor. They do not identify the separate contributions of labor, capital, and technology. Changes in productivity include the effects of all (except hours of work) possible influences on output - technology, ability, skills, and effort of labor, capacity utilization, managerial skills, and the amount of capital.

Other periodic announcements report multi-factor productivity indexes, which do measure the separate effects of hours of labor, education levels and experience of labor, amount of capital, and the effects of technology change.

Importance Of Productivity Changes For Economic Growth

Our capacity to produce goods and services is determined by how much labor we have, how many hours workers work, the workers' skills and intensity of work, the amount of capital workers have with which to work, and changes in technology. Over time, real GDP in the U.S. has increased for all of these reasons. We have a larger population with a larger percentage working. In the last ten years, the average worker has been working longer hours. The workers have significantly larger amounts of capital and new ways of producing and organizing production have been put in place.

The productivity measures capture the effects of the increased capital, the increased experience and education of workers, and the new technology. If productivity increases faster than population growth, real GDP per person can increase and we can all enjoy higher standards of living.

The Impact Of Revisions To Productivity Data

The "preliminary" productivity figures are announced slightly more than one month after the end of a quarter. The "revised" productivity figures appear after one more month.

Periodically, additional revisions are made to the productivity data. This last summer revisions were made in the 1999, 2000, and the first quarter 2001 figures. The effects of those revisions were to lower the previously estimated increases in productivity. For example the rate of increase for 1999 was lowered from 2.6 to 2.3 percent and 2000 lowered from an increase of 4.3 percent to an increase of 3.0 percent.

These revisions have received a great deal of press attention - primarily focused on the overestimation of productivity growth. Despite the downward revisions in last two years' productivity growth, productivity was still increasing; the gains were just smaller. Increases in productivity over the past few years has allowed companies to generate more revenues, leading to higher profits and wages without inflationary pressures. Therefore, although the data may have overstated the increases in productivity, the effects of increases in productivity on the economy were real.

A Classroom Activity On Productivity

Assessing the Effects of Capital, Labor, Technology, and Learning on Output

Economic growth is dependent upon changes in the levels of capital, the labor force, and technology in a country. Increased productivity and technological change will allow for increases in output and increases in wages without affecting the price level. The relationships among factors affecting productivity and output are illustrated in the following activity.

First, divide the classroom into four equal groups and distribute construction paper to each group. Explain that each group is a country and that the paper represents their natural resources. Tell two people in group one that they will have one minute to take their construction paper and tear it into circles the size of a fist. Their goal is to make the most circles in a minute. This may require some quality control to ensure that legitimate circles are being produced. When one minute has elapsed, collect and tally the number of circles. Show examples to the class and ask what should be done to increase the production of circles or the quality of circles.

In the second round, distribute two scissors to two people in group 2. Explain that the two students will be given one minute to cut out as many circles (the size of a fist) as they can. When one minute has elapsed, collect and tally the number of circles. Discuss how the output changed with the addition of capital to this economy. Compare examples of the circles made with scissors to those made by tearing and determine if the addition of capital has increased the quality of the product. You may also discuss how you might count the number of rather crude circles in the first round, compared to the larger number of better circles in the second round.

In the third round, have four people in group 3 cut out circles with the same number (2) of scissors. Explain that they will have one minute to cut out as many circles as possible. When one minute has elapsed, collect and tally the number of circles. Discuss how the gross output changed with a larger labor force. Then divide the number of circles produced by four to determine the productivity.

Finally, ask the entire class to discuss what other aspects of circle production might be altered in order to increase the number of circles produced or the quality of the circles. Then select four people (group 4) and have them use whatever resources available to produce their circles. (They may use a compass, trace a coke can, or use other forms of approximating a circle.) When one minute has elapsed, collect and tally the number of circles. Discuss how the output changed with the addition of learning and innovation, and perhaps more capital. Compare examples of the circles made with the new technology and the additional learning, to those made by an increase in labor, to those made with scissors, to those made by tearing and determine if this additional information has increased the quality of the product.

Questions

If these groups were four separate countries (one with only labor, one with labor and capital, one with a larger labor force and capital, and one with enhanced technology), which would have the highest productivity rates? Compute productivity and real GDP per capita (the size of the class) for each scenario.

Compare the circles from the economy with only labor and the economy with labor and capital. Which of the two produced the higher quality circles? Which circles do you value more? How might the quality of some circles be reflected in prices?

When the labor force increased, did each of the workers have the same productivity rates? What do you think are the effects of higher education on productivity per worker? As an employer, which workers would you hire?

What were the effects of a classroom discussion on circle production? How is this like trade between countries? Will trade increase productivity in individual countries?